1. Is the Market efficient? Why or why not? What does it mean to say that the Market is (or is not) efficient? If the Market is efficient, how do you explain situations like the "Crash of 1987" when the value of the market dropped 25% in only one day? If the Market is not efficient, what does that mean for investors, and the process of asset valuation?
2. You have developed the following data for Asset "A" and the Market. Assume that the four states of nature include all possible states:
|
State
|
Return on Asset A
|
Return on the Market
|
|
1
|
-15
|
-5
|
|
2
|
5
|
0
|
|
3
|
20
|
15
|
|
4
|
30
|
20
|
The rate on T-Bills is 2 percent.
Given this information, and assuming that the CAPM holds, should the Asset ("A") be added (bought) or sold (in a well-diversified portfolio)?
3. What does the CAPM suggest for investors? What value does it hold for Corporate Financial Management, as opposed to investors in individual financial assets (like stocks and bonds)? What does market efficiency suggest about CAPM or vice versa?
4. An investor purchased a bond, at par, on the day it was issued. The bond carries a 5 percent coupon, paid semi-annually, and has 20 years to maturity.
Five years later (five years after the bond was issued, the Yield bonds of similar risk and maturity are paying 6 percent (Yield to Maturity). What should a rational investor be willing to pay for this bond?
If the bond in part (a), above (as of five years after issue), was actually priced at $920, what would be its Yield to Maturity?
Ten years after the bond was issued, the Yield to Maturity on bonds of similar risk is 4 percent. What should a rational investor be willing to pay for the bond then?
Fifteen years after the bond was issued, the rate has not changed from the 4 percent in part (b). ?How much should the bond be worth (its price)?
In (d), since the YTM did not change (still 4%), why did the price change from the answer in part c?
5. A firm I am considering purchasing has $200 thousand in "Free Cash Flow" projected for next year (2011), $100 thousand in 2012, and that is expected to grow at a constant rate of 4.5% each year after 2012. You have determined that the appropriate discount rate to apply is 13%, based upon the WACC of the firm.
What would be the terminal value for estimating the value of the firm (and, as of when)?
How much should I bid for the firm (as of the end of 2010)?
6. In estimating the value of a firm, we first estimated the Free Cash Flows available. Explain the concept of Free Cash Flow. Why is it different than Net Income Available to Shareholders in valuing the shareholders' investment? What is more important (and why...), Income or Cash Flow? What adjustments did we need to make to Operating Cash Flows to arrive at Free Cash Flows, and why are those adjustments necessary? Explain your answers in a clear and concise essay.